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Online Auctions Offer Big Contracts, Slim Profits
Indepth Report: Is the buying and selling of pallets over the Internet via online auctions everything it's cracked up to be? Complete overview of pitfalls, strategies, experiences.
By Chaille Brindley
Date Posted: 6/1/2000
To bid or not to bid, that is the question for many pallet manufacturers and recyclers across the country. Since FreeMarkets, Pittsburgh, Pa., first came on the scene late last year, bidding online for pallet contracts has become a topic of concern. For an industry that is already slim on profits, online auctions could spell disaster if suppliers do not wise up and learn from their mistakes.
FreeMarkets is the most established procurement auction company, having completed over $5.4 billion in transactions since the company started in 1995. Major companies such as Quaker Oats, Owens Corning, GE, and Honeywell have given online pallet auctions a try. FreeMarkets boasts that it has saved clients on average 15% across a broad array of products and services from pallets to tax preparation. And online procurement shows no signs of stopping. According to industry sources, FreeMarkets conducted pallet auctions in May for BP Amoco and Mack Trucks. The BP Amoco auction for $2.4 million worth of pallets included lots in Illinois, Ohio, Texas, Alabama, South Carolina and Georgia. The auction for Mack Trucks was much smaller with lots in Maryland, South Carolina, Pennsylvania, Illinois, Georgia, Texas, Nevada and Ontario.
FreeMarkets has put a different spin on auctions. Called a reverse auction, FreeMarkets’ format pits sellers – not buyers – against each other. Unlike a conventional auction, a bidder’s identity is kept secret. Pallet suppliers go online and bid against each other driving the price down. FreeMarkets gives the bidding information to the pallet user who makes the final contract decision.
The major concern for pallet suppliers is the affect on price. Typically, the pallet industry runs on 3-5% before tax profit levels. Some of the most profitable companies may have margins of 10%. Over the years, the sheer number of pallet companies has led to an extremely competitive industry without much wiggle room on price. Online procurement companies such as FreeMarkets come along and try to take a bit off the price plus factor in the cost for their services.
Actual FreeMarkets pallet bids have gone as low as 23% below the reserve price, the point at which it makes sense for the buyer to move the business to another supplier. Pallet industry sources have estimated that FreeMarkets reserve prices range from 3 to 5% below the current costs. However, the reserve price formula remains a mystery. With the cost of goods in the pallet industry averaging close to 85%, many of the online bids appear below cost.
"Pallet people are going online and bidding business at ridiculously low prices," said Frank Falzone, president of FPF Pallets Plus, Chicago, Ill. "Most pallet companies don’t know how to calculate their costs."
FPF Pallets Plus had not lost any business due to online auctions. The company only bid on prospective accounts. But it has not won any of the contracts either. Why are pallet companies jumping into the shark-infested waters of online auctions? They are digging for gold. Many FreeMarkets auctions have been for contracts worth millions of dollars, and suppliers bid in hopes of making up the difference in volume.
Many pallet suppliers view FreeMarkets as the enemy. But is FreeMarkets the real problem, or is it the pallet suppliers that drive prices down to get business? Some pallet companies have refused to participate in online auctions. Bill Schneider, vice president of sales for Remmey The Pallet Co., Southhampton, Pa., has not participated in online auctions because he does not feel it is a good way to sell. However, he does not blame FreeMarkets for the falling pallet prices. Bill said, "What did FreeMarkets do, other than turn on everybody’s computer? They just help everybody bid the price down as a good auctioneer would."
FreeMarkets offers over 30 different reverse auction formats. Some auctions involve more than one type of currency. Features unique to FreeMarkets include the "Take the Market" button, which allows a company to undercut everyone in the market and become the low price leader. The actual bidding process may take three to four hours, with contracts grouped into specific lots based on part and geographic region in order to ensure fair comparisons. The process may be briefer for products where pricing is more volatile.
Details of the auctions differ from customer to customer. For example, some auctions require suppliers to bid at or below the reserve price in order to participate. Other auctions do not. Contract lengths vary from 90 days to three years.
FreeMarkets bases its fees mainly on volume, not savings. Fees depend on order size and how much resources a particular account requires.
FreeMarkets identifies suppliers and trains them on the software. The company follows up an auction by collecting cost break-downs from suppliers to validate bids. The buyer in an auction conducted by FreeMarkets is not obliged to go with the lowest bidder; the buyer may choose a higher bid, depending on other factors. Also, the customer can decide to opt out of the contract at any time. But the supplier cannot.
Is the Pallet A Commodity?
The pallet industry has worked to dispel the notion that all pallets are created equal. When a product is viewed as a commodity and service is thrown out the window, the buyer wins because suppliers compete solely on price. Over the past 10 years, the pallet industry has struggled to earn some degree of respect for the various levels of service that suppliers provide. But with the emergence of online auctions, the pallet is placed back in the commodity category. The fact is wood pallets are mainly a customized product. Customers want different delivery schedules, varying amounts of wood in pallets, back dock sweeps, etc. Opinions on the commodity issue are as different as the company owners.
"FreeMarkets is picking on pallet companies because the industry sells on price, no matter what others tell you," said Frank. "The pallet industry is based on price, and FreeMarkets is taking advantage of that."
Others believe there is more to a pallet than just price. Richard Montest of Woodworks Unlimited, Moon Township, Pa., said that FreeMarkets misses the bigger picture because it looks at everything as a commodity. Although the pallet in its base form is a commodity, services and expertise differentiate suppliers. Marc Ottinger, director of The Nelson Company, Baltimore, Md., agreed that pallet companies are not selling a commodity and quality is an issue. Marc said, "I have seen it with some customers. They push as much wood out of the pallet as they can. All of a sudden, they are getting damage on the product. Then they come back and want to know how they can decrease damage."
Will the future of the industry be dominated by price and volume? FreeMarkets is banking on price as a driving factor for many industries beyond just pallets. "The suppliers who have created more relationship-based selling, they are not going to grow as fast as the suppliers who are the low cost producers," said Jim Zuffoletti, vice president of diversified manufacturing for FreeMarkets.
Screening – Are You Who
One of the services that FreeMarkets offers is pre-screening of applicants for online bids. Pre-screening mainly consists of collecting lengthy questionnaires from prospective suppliers. The problem is not the questionnaires as much as the lack of verification. The real burden for verifying participants falls on the pallet user, not FreeMarkets. None of the pallet suppliers who gave information for this article were inspected or called to verify the information that they submitted to FreeMarkets. According to participants, some of the auctions involved companies that did not have the product capacity to fulfill the lots.
Richard said, "FreeMarkets did not know us from a hole in the wall. We sent back our survey, and I could have written anything in there. I could have been working out of a phone booth on the turnpike."
The funny thing is that FreeMarkets monitors to see who goes online the day of the auction. But in the cases investigated by Pallet Enterprise, neither FreeMarkets nor the pallet customer appear to spend much time verifying information submitted by the bidders. Unqualified bidders create a problem for everyone. They may not have any experience with large orders and thereby bid unrealistically low prices. Plus, these companies just add more work for the pallet customer when all the bids are collected. And unqualified bidders taint the perception of FreeMarkets’ system. Some pallet companies have suggested that FreeMarkets and its customers have not tried to weed out unqualified candidates because the more participants in the auction, the fiercer the competition, and the lower the price.
Defining the Bid Specification
One of the biggest areas of contention is the bid specification. Small changes in dimensions and board thicknesses can drastically affect cost. Several bidders contend that the pallets FreeMarkets’ customers were currently getting differed from bid specifications. Either the customer did not know what they were currently getting or the current supplier cheated on the specification.
"Ninety percent of the time, the customer does not know that they are getting out-of-spec pallets," said Marc. "The pallets are working, so it becomes a non-issue."
In the online auction for Owens Corning, half of the pallet sizes were incorrect according to a supplier, who was familiar with the account and actually field measured the pallets. The specifications mostly called for pallets that were heavier than what the customer was actually receiving.
Bid specifications that did not take into consideration value-added services were a problem for some suppliers. Many local plants have special side arrangements for services that the corporate purchasing staff may not know about. Sam McAdow, CEO of The Buckeye Group, South Charleston, Ohio bid on an auction strictly on the specification which did not include some of the value-added services they were currently offering to a customer. But when they won the contract, the customer wanted the pallets at the bid price with the value-added services included. But Jim of FreeMarkets said, "We absolutely want suppliers who participate in the markets to bid against the specification."
When a supplier gets in a heated discussion over the specifics of the bid, it is a lose-lose situation for everyone. Giving FreeMarkets recognition where it is due, the company does strive to update the specifications and keep all participants notified of changes. Several pallet suppliers admitted receiving numerous updates as participants asked questions.
Your Bid Is A Contract
Bidding in a FreeMarkets auction should never be taken lightly. A supplier is obligated to provide the product at the bid price. If the winning supplier cannot fulfill the contract, it may be required to compensate the customer for the difference between its bid price and the actual price the customer pays from another supplier. Since FreeMarkets never actually takes title to goods or services sold via its auction, the company does not get involved in legally enforcing the contracts.
"The buyer may independently go after the supplier. We would not be a party to that. But, we would not allow that supplier to participate in our system in the future," said Lori Ginocchi, market maker for FreeMarkets.
The law may not be on the customer’s side unless the supplier was the lowest bidder. Most state laws only allow a party to sue for actual damages when another company is in breech of contract. If a buyer has other options at lower costs, there are no damages. The pallet customer cannot claim any damages and has no real benefit to sue. Check with your lawyer about the law in your state.
Although many auctions resulted in significant cost savings, not all did. In some auctions, participants never bid below the reserve price. According to one supplier, Allied Signal is still out looking for a lower price. Online auctions may automate some of the quote gathering process. However, fine-tuning the contract still seems to take as long as in the past. Several pallet auctions that were conducted earlier in the year are yet to be finalized; customers and suppliers are still negotiating terms and some are still hunting for better deals. In the mean time, pallet companies that are retaining business at lower prices are in no rush to finalize the new contracts because they are still supplying the customer pre-FreeMarkets products at pre-FreeMarkets prices.
Online auctions hurt manufacturers more than brokers. Sam said, "The day of the auction, brokers were calling all over the place trying to get prices. I even know of a case where a broker bid the lowest price, and called us the current supplier and said we could keep the business if we cut our cost by 7%. Three months later, the broker walked from the entire deal."
Brokers can better shield themselves from lawsuits because they don’t have machinery and other hard assets. They can shut down and start up the next day under a new name. Pallet manufacturers may have to face the music if they bid at a price they can’t deliver.
Online auctions also give corporate purchasing more information about pricing, which allows them to better track options for a particular plant. Although this may have many benefits, it also comes with a drawback. Online auctions may be exacerbating the divide between corporate purchasing and the individual plant leaders. Plants never like to be told what to do by corporate. Frequently, corporate headquarters wants to change vendors to save a dime and retool procedures. Plant managers have a system that works for them. They do not want to risk production decreases or increased product damage because of changes made by the top brass. Online auctions do not cause the problem. But they do give the "suits" another tool to reign in costs at the local level, and what looks good on paper may not work in reality. "Big companies are run by the accountants. Corporate headquarters make the decision to use FreeMarkets, and plant managers are caught in the middle," said Frank.
Options to FreeMarkets
Are there options besides FreeMarkets? Yes, there are a number of online exchanges and marketplaces currently on the Internet. Most are excess inventory or capital asset sites. Unlike FreeMarkets, these auctions are not for consistent suppliers of everyday goods needed for industrial production. But one company with a mission similar to FreeMarkets is SupplierMarket.com (SMC), Burlington, Mass.
SMC works a little differently than FreeMarkets. It provides an open market for buyers to come and post requests for price quotes (RFQ). Buyers can setup a personalized Web page to display RFQs. According to Mike McAdow of The Buckeye Group, the prices tend to be more scattered than in a FreeMarkets auction. The Buckeye Group participated in auctions for plastic stretch wrap. In the SMC system, buyers must work through SMC to obtain the contact name for the winning supplier. Unlike FreeMarkets, where the buyers pay the fees, SMC charges the supplier a 2-4% finder’s fee. RFQ listings and bids are free. Mike said that SMC focused more on the seller and smaller order lots.
"We are more for self-service procurement. If you know what you want to buy, you can very easily come to our site and use our online RFQ builder to find suppliers across the country," said Holly Allison, vice president of marketing for SupplierMarket.com. "We are neutral in our dealings. We support neither the buyer nor the seller."
SMC only focuses on built-to-order products. Nothing comes from a catalog. "Corrugated cartons, packaging materials, and both wood and plastic pallets have been sold on our site," said Holly. Unlike FreeMarkets, where a bid is a contract to supply at a certain price, SMC gives both the buyer and the winning supplier the option to walk away at any time during the 30 day decision period. SMC also provides a transaction rating system that is similar to the one used
Some companies have opted to develop their own online procurement system. Shortly after FreeMarkets went public, General Motors backed away from outsourcing procurement to the online auctioneer. Instead, the automaker has developed its own site called GM TradeXchange with the help of Commerce One. According to a recent article in Inter@ctive Week, the promise of online super exchanges for specific
Online auctions may be a big part of the future. But will third party providers such as FreeMarkets be in the picture? Jim of FreeMarkets said that the third party model works and will be around for a long time. He said that a company like FreeMarkets brings a significant amount of experience, technological expertise and time savings to a customer. While corporate America is living in the era of outsourcing everything, will companies trust their valuable supplier relationships and contacts to a third party?
Instead, the direct business approach may be the future. "The only value FreeMarkets is adding to purchasing is driving cost down. You can see this by what GE ended up doing with its lighting division. They decided that they were going to do this themselves and do
"Online bidding will be part of the future. Any purchasing manager should be able to put it together. Online bidding from a third party will not work. Companies will eventually see how insidious reverse auctions are," said Richard.
No matter who does them, online auctions and e-procurement appear to be here to stay. The Internet can streamline and improve the speed of the bid gathering process. The Web opens up business to a whole new world of suppliers. Right now, Fortune 1000 companies are the ones taking advantage of e-procurement. But the Internet will allow smaller businesses to band together to increase their purchasing power. The simple fact is online auctions such as FreeMarkets have been able to cut costs.
"We are in the very beginning stages of online commerce, and FreeMarkets has been successful in getting bids
Online Dangers & Tips
• Read the Fine Print – In some systems such as FreeMarkets, your bid is a contract. Read all contract language and bid specifications. Know what you are getting into before you turn on your computer. Find out how long you will have to hold the pricing.
• Bid the Specification – Ask questions and make sure you fully understand the bid specification including value-added services, delivery schedules, etc. Keep in mind that what the buyer is currently getting may not be what is in the bid specification.
• Know Your Cost/Develop a Strategy – Prices will fall. Make sure you understand your costs down to the penny. FreeMarkets requires bidders to supply them a cost break-down after bid day. The NWPCA has pallet costing software and can assist members in understanding their costs. But as Bob Peters of NWPCA cautioned, "Garbage in, garbage out. You have to know the figures." NWPCA: 703/527-7667.
• Set a Low Price & Stick to It – One of the mistakes several leading pallet companies made was that they got caught up in the euphoria of the auction. In the pursuit of the large volume account, they bid below their predetermined lowest price. Even FreeMarkets recommends setting a low price before the auction and sticking to it. Just because you are not the lowest bidder does not mean that the contract will go to some other supplier. The pallet customer can pick from any supplier that bids.
• Register to Win Bids – The only way to know of upcoming auctions of interest is to register. Pallet suppliers can register online at www.freemarkets.com or www.suppliermarket.com.
• Be Prepared to Walk Away – If the prices drop too low, be prepared to give up the business. Trying to make up profits in volume does not work most of the time. Frequently, you can find a customer who will pay more. Why sell your product for less?
FreeMarkets Strategies To Consider
• Aggressively Bid on Price – If you are a low cost, efficient producer, trying to capture the business on a low price may not be a bad strategy. Make sure you know your cost. Remember, you do not have to be the lowest bidder to win the contract, and there is a difference between low and ridiculously low prices.
• Get Your Name in the Hat – Companies that do not place bids in FreeMarkets auctions are not eligible to do business with the particular pallet user. Place bids at current or reserve prices based on rules of the particular auction. Some auctions have required companies to bid at least the reserve price to participate.
• Eye on the Market – Register to bid for all eligible auctions in your area. Receive the bid packet from FreeMarkets. This allows you to know what is going on and how the market is reacting to online auctions. If you must bid the reserve price to participate and you think the reserve price is too low, drop out. If you can supply at reserve price, participate in the auction and watch the bidding.
• Don’t Play the Game – If pallet suppliers boycott FreeMarkets and sell instead on service, quality and relationships, they may lose a big account but come out ahead in the long run. Decide your corporate sales strategy and make it work.